Why has consumption been so slow to recover?

John Cochrane has a very interesting post on this topic, here is one excerpt but it is quite wide-ranging:

New Keynesian models are a bit fuzzy on just why interest rates have to be so low — why the “natural rate” is sharply negative and why zero interest rates aren’t enough. Many of the formal models assume that consumer’s discount rate (rho) has declined sharply, beyond the capacity of the interest rate to follow it. If rho goes to, say -5%, with our 2% inflation, then even a zero nominal interest rate is like a 3% real interest rate. (These are deviations from trend, so one might not need actually negative discount rates to hit the zero bound. But even adding growth, it’s hard to avoid the need for a negative natural rate to cause a problem of this size.)

Now, a spontaneous outbreak of thrift, to the point of valuing the future a lot more than the present, seems a bit of a strained diagnosis for the fundamental trouble of the US economy.

To be fair, all the papers I’ve read say clearly that they regard the decline in the discount rate rho as a stand-in for some more complex process involving the financial crisis. For example, a more precise version of my first equation adds a “precautionary saving” term. When people are very uncertain about the future, they save more, just as if they had become much more patient. In equations,

[TC: see the equations in his original post, I don’t get them to reproduce]

This story seems possible for 2008 and 2009, in the depths of the financial crisis and recession. But I’m less convinced that it describes our current moment. Just look at the graph. Our state is one of steady but sclerotic growth, not one of great consumption volatility.

For my part, I get nervous when I read Keynesians claiming that the real rate of return is negative these days.  Is civilization moving backwards?  (And if so, don’t we really have a budgetary problem?)  I prefer instead to think about segmented rates of return and wonder why that has come about, and if so how we actually measure opportunity costs for projects.  If the risk premium on private projects is quite high, motivating a rush to T-Bills, is then the risk premium on government projects high or low?  Does “the chance that the government repays my loan,” as measured by bond rates, equal “actual comovement consumption risk of the government project itself”?  I see those two variables confused all the time.

Cochrane’s post is also very interesting on the differences between new and old Keynesianiam.


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